The Foreign Exchange Exposure of Banking Institutions: The Direct and Indirect Sources of Exchange Rate Risk
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This paper advances the effort to understand foreign exchange exposure of banking institutions by elaborating its sources. Previous studies fail to specify the sources and the direction of the exposure. I show that exchange rate changes positively affect the value of banks during their net short assets position, but hardly affect their performance during their net long assets position. Consistent with previous studies, increases in the value of domestic currency have negative effects on banks’ net foreign currency denominated assets. Furthermore, an appreciation of the domestic currency affects positively banks’ outstanding value of domestic loans.
Abstract
This paper advances the effort to understand foreign exchange exposure of banking institutions by elaborating its sources. Previous studies fail to specify the sources and the direction of the exposure. I show that exchange rate changes positively affect the value of banks during their net short assets position, but hardly affect their performance during their net long assets position. Consistent with previous studies, increases in the value of domestic currency have negative effects on banks’ net foreign currency denominated assets. Furthermore, an appreciation of the domestic currency affects positively banks’ outstanding value of domestic loans.
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